This blog was last updated on February 14, 2025
Talk of tariffs dominates the current news cycle with some commentators suggesting that tariffs will spell disaster for our economy while others say the exact opposite. We’ve seen the stock market sometimes fluctuate as tariffs are announced but later suspended, leaving us to wonder whether an aggressive tariff policy is good, bad or something in between.
There are many ways to view the use of tariffs and to analyze their impact. As we are focused on how things affect indirect taxes here at Sovos, we’ll examine tariffs through this lens.
How Did We Get Here?
It all started at the September 10, 2024, Presidential debate when the Democratic Presidential Candidate answered a question about the economy by suggesting that now President Trump’s economic plan would “increase sales taxes for the middle class.” At that moment, all of us working in the world of sales tax collectively stood at attention. What are the candidates talking about? In the US, sales tax is almost entirely controlled by state and local governments. While there have been occasional calls for a national sales tax, none garnered any serious political consideration.
As it turns out, they were talking about tariffs. While both tariffs and sales tax are forms of “indirect tax” they operate very differently and often serve entirely different objectives. However, they are not entirely disconnected. As explained below a tariff can, and often will, have a downstream impact on sales tax collections.
Since it seems likely we’ll spend considerable time over the next four years discussing tariffs and their impact on the economy, it’s worthwhile to spend a moment to lay down some basic terms.
What is a Tariff?
Simply said, the term “tariff” refers to a tax imposed by a government on imported goods. Tariffs are a form of customs or duty. Historically, tariffs have been used as an economic policy tool to protect domestic producers or as a retaliatory measure (often called a retaliatory tariff) against perceived unfair trade practices. Tariffs can be levied as a percentage of the selling price or as a fixed amount per item.
While tariffs are intended to disadvantage foreign products, it’s important to understand that they are frequently paid and remitted by the domestic entity importing the goods and not by the foreign supplier. In this scenario, the country subject to the tariff theoretically becomes “disadvantaged” because once the tariff is accounted for, the cost of buying the foreign good will often be higher than the equivalent domestic supply or one from a country not subject to a tariff.
Downstream Effects of Tariffs
Assuming they are not constrained by a pre-existing contract, buyers faced with paying tariffs have three basic choices. They can switch suppliers, absorb the impact of the tariff and reduce their profits, or pass on the cost of the tariff to their downstream customers. The choice a given company might make will be largely dependent on the economic forces prevailing in their industry, but Economics 101 suggests that if a company can pass the impact of a tariff to their customer by increasing prices, they certainly will.
So, the general point that an aggressive and comprehensive tariff policy has the potential to increase the price customers pay on imported goods is a valid one. For example, the Peterson Institute for International Economics projected that the recently proposed tariffs on Canada, Mexico and China would have cost the typical US household over $1,200 a year. In making this projection, they noted the pernicious possibility that domestic producers could use the tariffs to their advantage by raising their own prices to just below the tariff-adjusted price of their competitors.
How Does Sales Tax Really Figure In?
While some consumers import items directly, most imports happen earlier in the supply chain, meaning companies import products to re-sell directly, use as an ingredient or component part in a product that will be resold, or are importing machinery/equipment/supplies to be used in the production process. This means that tariffs are assessed before the point of final consumption. Sales tax, by contrast, is assessed at the end of the supply chain at the point of final consumption. Most often, sales tax is reflected as a separate line on an invoice.
While every state applies sales tax differently, most states have adopted a definition of taxable “sales price” that includes all receipts received by the seller. Take for example the definition used by the 24 member states of the Streamlined Sales Tax Initiative.
“Sales price” applies to the measure subject to sales tax and means the total amount of consideration, including cash, credit, property, and services, for which personal property or services are sold, leased, or rented, valued in money, whether received in money or otherwise, without any deduction for the following: (i) The seller’s cost of the property sold; (ii) The cost of materials used, labor or service cost, interest, losses, all costs of transportation to the seller, all taxes imposed on the seller, and any other expense of the seller; (iii) Charges by the seller for any services necessary to complete the sale, other than delivery and installation charges; (iv) Delivery charges; (v) Installation charges; and (vi) Credit for any trade-in, as determined by state law.
In other words, the taxable base upon which sales tax is applied includes all costs incurred by the seller including “taxes imposed on the seller.” This means that in the likely case that a tariff imposed earlier in the supply chain caused the final sale price to increase then the sales tax paid by the final consumer at the end of the supply chain will also increase.
Let’s Use an Example
People love guacamole so let’s frame this whole situation using avocados. Prior to the proposal being suspended, the US would have imposed a 25% tariff on most imports from Mexico, including avocados. Mexico is the world’s largest avocado exporter and supplies 80-90% of the avocados consumed in the US. A US grocer importing avocados from Mexico would have to pay this tariff at the border or find a domestic or alternate foreign supplier at a lower price. Assuming they are unable to do so and if market forces allow, the US grocer will likely raise their prices to recoup the cost of the tariff. Let’s do some simple math:
- US Grocer buys from Mexico Supplier at $.50 per avocado.
- US Grocer pays $.13 in tariffs (rounded up)
- US Grocer increases retail sales price from $1.00 to $1.13 to recoup tariff expense.
- Assuming a 7% sales tax rate and assuming grocery food is subject to sales tax, the tax on the avocado increases from $.07 to $.08 (rounded up)
- US Consumer pays an added $.14 per avocado ($.13 to the US Grocer and $.01 to the state government.)
Of course, if we are talking about a $1,000 computer or $10,000 office machine imported from China, where 10% tariffs may still be imposed, the impact on consumers will be even greater.
Where Does It Go from Here?
While I am no expert in international relations, it seems clear that the new administration is using the threat of tariffs as a negotiating tool to gain political concessions that may not always relate directly to the economy. However, should more tariffs be enacted and enforced over an extended period, consumers are likely to experience increased prices. As noted by Joseph Stiglitz, an economics professor at Columbia University and a winner of the Nobel Memorial Prize in Economic Sciences, “Virtually all economists think that the impact of the tariffs…will almost surely be inflationary.”
That said, it is critical that businesses stay abreast of what is taking place and keep themselves informed as to how any of these changes could impact their tax positions and compliance posture.
Take Action
Talk with a tax compliance expert for more information about how Sovos can help with your questions about tariffs.
